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Roth 401(k) Rollover into Roth IRA


Hello Dan,

Are you unsure about the rules for rolling over a Roth 401(k) into a Roth IRA? We understand that your ultimate goal is to retire early and withdraw your Roth contributions tax-free until reaching the age of 59½. Currently, you have both a Roth 401(k) and a Roth IRA that have been opened and funded for more than five years. Now, let’s delve into how Roth 401(k) earnings and contributions are handled once they are rolled over into a Roth IRA.

Handling Contributions and Earnings

The rules state that funds preserve their character after a rollover, meaning that contributions remain contributions and earnings remain earnings when transferred between accounts. To provide a clearer understanding, consider the following hypothetical scenario:

Let’s assume you have contributed $50,000 to your Roth IRA over the years without converting any traditional IRA to your Roth IRA. At present, your Roth IRA has a total value of $100,000. Additionally, suppose you have contributed $75,000 to your Roth 401(k) without making any conversions from other sub-accounts within your 401(k). Your Roth 401(k) is currently worth $150,000.

An Example Scenario

By rolling over your Roth 401(k) into the Roth IRA, you will end up with a $250,000 Roth IRA. Out of this amount, $50,000 represents your original contributions to the Roth IRA, while $75,000 represents your contributions to the Roth 401(k). Consequently, $125,000 out of the total $250,000 in your Roth IRA are considered contributions.

Best regards,

Understanding the Distribution Rules for Roth IRAs

The ordering rules for distributions from Roth IRAs provide an advantageous way to access funds from your account. One key benefit is that you can withdraw contributions tax-free, regardless of your age or the age of your Roth IRA. This means that the first $125,000 you withdraw is not subject to taxes.

However, once you exceed the $125,000 limit, the IRS considers you to be distributing earnings. Unless a specific exception applies, distributing earnings before reaching the age of 59½ may result in taxable income. It’s important to note that even if you no longer have your first Roth IRA account, if it has been less than five years since you opened it, you may still owe taxes on premature earnings distribution. Additionally, the standard 10% penalty for early taxable distributions may apply.

Fortunately, since you mentioned that your Roth IRA has been in existence for over five years, you only need to wait until you reach the age of 59½ to access all the funds in your Roth IRA tax-free.

There are certain situations in which you may be planning to leave your employer at a specific age. If you plan to leave your employer in the year you turn 55 or later (50 if working in certain public service jobs), and you anticipate needing some of the earnings before the age of 59½, it may be beneficial to keep your Roth 401(k) in the 401(k) plan. In this scenario, you can still withdraw contributions tax-free. However, once you begin taking out earnings, those earnings will be subject to taxation. The good news is that the usual 10% penalty for early distribution would be waived due to the exception for separation from service. It’s important to note that this exception only applies to participants in 401(k) plans who separate from service at the age of 55 or older, and not to IRA owners.

Note: Dan Moisand is a financial planner at Moisand Fitzgerald Tamayo, with offices in Orlando, Melbourne, and Tampa, Florida. The information provided here is for informational purposes only and should not be considered a substitute for personalized advice. Please consult your financial advisor to determine what is best for you. Some reader questions have been edited for clarity.

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